The Get Ahead Guide: Erin McKenna Makes the Best Cupcakes in New York City

Walk into BabyCakes NYC, a vegan bakery in New York City, and you feel as if you have entered a sweets shop right out of Valley of the Dolls. The place is packed with Nancy Sinatra records, Pyrex-style plates, and other '60s memorabilia. But though the vibe is decidedly mod, the business is very 2008. BabyCakes sells gluten-free cupcakes, brownies, cookies, and pastries, made with ingredients such as coconut oil and bean flour and topped with agave-nectar frosting. New York named BabyCakes' cupcake the city's best in 2006, and founder Erin McKenna has been featured on Martha Stewart's show. A second BabyCakes store will open this fall in Los Angeles.

The founder: McKenna, 32, grew up in San Diego, the 10th of 12 children in her family. A few years ago, she was working as a fashion assistant at Budget Living when she was found to have wheat allergies. Unable to find a vegan bakery that could satisfy her sweet tooth, she decided to start her own, on the Lower East Side of Manhattan. Her friends in the fashion world helped her generate buzz. Wendy Mullin of Built by Wendy, a trendy clothing label, designed BabyCakes' uniforms, and Earnest Sewn, a hip denim line, is partnering with McKenna to share costs as both businesses expand to L.A.

The numbers: Founded in late 2005 with $85,000 in seed capital, BabyCakes NYC broke even after only seven months. Last year, sales hit $690,000. This year, the company will gross $1.2 million, according to McKenna, with gross profit of $497,000 and net income of $100,000. That's pretty good, given that, as with most food businesses, BabyCakes' markup on specific items is low. Each cupcake, for example, costs $2 to produce and retails for $3. Next year, with a second store open in Los Angeles, McKenna projects sales of $1.8 million.

The market: Some 12 million Americans suffer from food allergies, according to the Food Allergy & Anaphylaxis Network, and many of them choose a vegetarian or vegan diet. Sales of vegetarian foods hit $1.2 billion in 2006. Vegan cooking is growing in popularity, too. To capitalize on these trends, Kraft (NYSE:KFT) and Kellogg (NYSE:K) market products geared toward people with food allergies, and Whole Foods (NASDAQ:WFMI) dedicates ample space in many stores to a line of gluten-free baked goods.

Challenges and opportunities: "Right now, I only want to focus on growing my business into a brand," says McKenna. That may be easier said than done: There are at least eight other "Babycakes" bakeries in the U.S., including one near L.A. that also sells vegan products. McKenna has been aggressive for a baker when it comes to protecting intellectual property. Each employee signs nondisclosure and noncompete agreements that are good for three years from the date of hire. "I knew from the moment I had the idea for the business that I had better talk to a lawyer," she says.

Rising food costs are another concern. McKenna works with specialized ingredients that are often provided by small, independently owned suppliers, so her costs are pretty high. The more stores she opens, the more leverage she will have to negotiate prices. For now, she looks for creative ways to keep costs down. For example, McKenna has a cookbook coming out soon. In exchange for a discount, she mentioned some of her suppliers in the book.

In terms of geographic expansion, McKenna's L.A. store will share a building with a new Earnest Sewn boutique, and the businesses will share the cost of the build-out and rent. After that, McKenna is intrigued with the idea of franchising. A number of customers have already expressed interest in opening BabyCakes stores in other cities, and she likes the idea of holding a competition that asks potential franchisees to submit videos pitching their merits. McKenna is also considering moving into packaged foods to be sold at upscale health food stores.

Advice from Tom Colicchio

Colicchio owns seven Craft restaurants and 12 'wichcraft shops and serves as co-host of Bravo's hit series Top Chef.

"Erin has a big business on her hands. Her food is delicious, and allergy-friendly foods have become a huge issue. If people are eating this way for health reasons, then they are fanatics, and if they are shopping at BabyCakes because their kids have allergies, then they are even more fanatical about it. But beyond health, she can also position her business as a lifestyle brand.

"Of course, you get involved with cooking because it's something you love to do. It's not something you go into thinking, I'm going to make a pile of money. There are easier ways to get rich. So if Erin decides she is going to grow her business, she needs to ask herself some questions. How quickly does she want to grow? Does she have the people to do it? Does she have the organization to get there?

"It's important to have a clear mission statement -- a clear list of tenets -- and I think she has that. Her employees are very clear when they come into work what's expected of them. They're going to have customers with certain needs, and they should treat them in a certain way. And when it comes to adding new menu items, refined sugar is never ever going to be in a recipe. Everyone who works for her understands that.

"As far as franchising, if you have people who can do it, then that's great. But the amount of work you have to go through to franchise is enormous. It's a lot of legal work. And even if you make it, it's hard to control your brand, especially if you're not that established. That said, I think it's smart that she's had employees sign NDAs and noncompetes. She has protected herself, at least to some degree.

"Personally, I believe that opening company-owned stores is a better way to expand. And Erin doesn't have to look to other cities or even other neighborhoods. At 'wichcraft, I've found that if we open two stores close together, they do more business than a store that's off by itself. Right now, we're struggling with the question of market saturation. How do you become a business that can grow without becoming something that feels like a chain? Because chain is sort of a dirty word.

"And then it's a matter, as a founder, of trying to figure out what you're best suited to do. In order to open up multiple locations as a chef or a baker, you have to check your ego at the door. The second you think nobody else can do what you can do, you're not going to grow. You have to rely on the fact that you can train someone, and that he or she will put his or her heart and soul into the business as much as you would. If you don't have that trust, it won't work."

Final thoughts from Erin Mckenna

"After hearing what Tom said about franchising, I will definitely think twice about it. Instead, maybe I'll open only bakeries that I'll own personally and when I can find people whom I trust to run them. I am going to focus most of my energy on packaged goods sold at health food stores. I think the key message is that if I keep everything creatively on track, the business will be OK."

BabyCakes NYC's Reality Check:

McKenna wants to build a brand, but several other bakeries use a similar name.

Recipes are notoriously hard to protect, no matter how much you try.

Franchising lets you expand quickly, but beware the legal costs -- and the loss of control over your business.